Book Review: Bailout Nation, by Barry Ritholz

Barry Ritholtz is the author of The Big Picture, a blog I became addicted to when I was trying to make sense of what was going on in the world during the last quarter of 2008. I still read it, but don’t parse every single word obsessively to quite the same extent. But I bought the book, at least in part, because Ritholtz had been so insightful when I was trying to understand what on earth was going on in financial markets, and it seemed fair that he should get some money from me in return.

From this distance, it is easy to forget that at the time, the events of August – December 2007 seemed pretty dramatic for the world economy. Not to mention the collapse of Bear Stearns in March 2008. Ritholtz started the book before September 2008, which gives him additional credibility, as much of what he says he was saying before Lehman Bros fell over.

The very broad thesis of the book is that the US economy has always been addicted to bailouts. Capitalism is all very well, except when it involves the richest people losing serious money. The history of the last century, and especially the last 10 years has been responsible for the mess that the US economy and the world financial system found itself in at the end of 2008. In his history of bailouts, which starts in a serious way, with the Lockheed Aircraft Corporation in 1971, Ritholtz has a whole chapter on the stockmarket bailouts post 1987. He has a very detailed account of all the different ways in which the Federal Reserve intervened to support the markets – starting in 1987, but continuing in 1994, through 1997 (remember Long Term Capital Management?) and the tech wreck in 2000, and of course, post September 2001. During much of that period, asset managers used to talk about the “Greenspan put” – that Greenspan wouldn’t let US equity markets fall too far before intervening to support them again.

The most damning section is the part where he talks about the failure of regulation – he has a superb “intermezzo” describing the failures in two pages in the form of a memo from Wall St to the government.

We [Wall St] may be the drunks, but you were our enablers. Your legislative, executive and administrative decisions made possible all that we did. Our recklesssness wouldnot have reached its soaring heights but for your governmental incompetence.

Along with the frequent reduction in interest rates to help the financial markets bubble so that they never fell, Ritholtz cites repeal of Glass- Steagall (the law that had separated commercial banking from Wall St) and the failure of the Federal Reserve to use its supervisory and regulatory authority over banks, mortgage underwriters and other lenders, who abandoned … standards” , among others.

And finally, after the introduction of all the things that were wrong with the financial system up to 2007, there is the story of the Global Financial Crisis itself, and all the various companies that failed, or (for the big ones) were rescued – Bear Stearns, Lehman, AIG, Citibank, Fannie Mae, General Motors… we seem to have slowed down now, but there are still banks failing every month in the US.

The book doesn’t pull its punches in this section, creating a list of the top 22 players who were to blame for the Global Financial Crisis. Number 1 is Alan Greenspan, but the next individual person named is Senator Phil Gramm for being the leader of the radical deregulation agenda pursued by the Senate, Congress, and both Democratic and Republican Presidents. In an interesting side note, the Ratings Agencies (Moody’s, S&P and Fitch) come in at number four. The company that was originally going to publish this book was part of the same group that owns S&P (McGraw-Hill) and ended up refusing to publish it.

The book (which was published in March 2009) ends up with some despairing commentary on what was done during the bailouts. Ritholtz argues that Treasury has been throwing good money after bad – that it has been following the Japanese model of fixing a banking crisis (broadly speaking, pretend that the assets are worth more than they are, don’t take the write downs, and hope that they come good eventually) rather than the Swedish model, which is to split the banks into good and bad banks, and conduct an orderly run-off of the toxic assets in the bad banks.

Fundamentally, in my view, if you believe that free markets are the best way to allocate resources, you have to be willing to let companies fail. Because there will always be mistakes. And the creative destruction of capitalism works best if companies are allowed to fail, and the resources (capital, employees, etc) are allocated to companies who can make better use of them. But the financial system is so important to the economy that it isn’t allowed to fail. And much of the financial system has been using this argument to get far more in taxpayer funded rescue than was really necessary to save it, after getting away with little or no regulation for many years.

Believing that a market based economy is the best way to allocate resources doesn’t mean believing that people in free enterprises are smarter or better at managing than people in government enterprises. It means that those who aren’t good at managing resources, or enterprises, have those resources taken away from them by the market after they’ve stuffed it up a few times. Except if their enterprises are regarded as too important to fail. In that case, they should be regulated closely, rather than given regulatory freedom without consequences, which seems to have happened particularly in the US and UK economies.

Since the book was written, Ritholtz has written a fewposts asking what the Obama team has been doing since the crisis:

When companies get to be that large, their vast wealth buys influence and power and corrupts the political system. Despite the crisis caused by the banks, just look at how successful their lobbying effort was. Their enormous pushback effectively neutered any true regulation of the finacial sector.

Sadly, much of it seems to be a continuation of how the US got into this mess in the first place – there is a huge regulatory benefit to be gained by being a large company in the US system. The Australian political system is certainly going in that direction too. It’s hard to make good policy if it is opposed by those who provide your campaign contributions. And the interests of the wider economy don’t have the same voice in campaign contributions as the interests of Wall St.

This book is a rollicking, opinionated read, by an author who really knows his stuff. Highly recommended if you would like to understand what has been going on in the world’s biggest financial market.

Like I haven’t got enough books on my ‘list of shame’! I may well have to add this one, though. The amount of money the UK has poured into RBS etc is quite frightening whilst on the other hand a £1 billion cut in HE funding has just been announced.

[…] This narrative is pretty ubiquitous, so I’ll give just two references: Russ Roberts in his paper “Gambling with Other People’s Money: How Perverted Incentives Caused the Financial Crisis” (he podcasts on it here), or Barry Ritholtz’s book Bailout Nation. […]